managerial accounting

Sales . . . . . . . . . . . . . . . . . . . . $150,000 Variable expenses . . . . . . . . . 90,000 Contribution margin . . . . . . . 60,000 Fixed expenses: Salaries . . . . . . . . . . . . . . . . . . . 27,000 Maintenance . . . . . . . . . . . . . . . . 3,000 Depreciation . . . . . . . . . . . . . . . 10,000 Total fixed expenses . . . . . . . . . 40,000 Net operating income . . . . . . .$ 20,000 The vending machines can be sold for a $5,000 scrap value. The company will not purchase equipment unless it has a payback period of three years or less. Does the ice cream dispenser pass this hurdle?
Payback and Uneven Cash Flows
Step 1: Compute the annual net cash inflow. Because the annual net cash inflow is not given, it must be computed before the payback period can be determined: Net operating income . . . . . . . . . . . . . . . . . . . . . . . $20,000 Add: Noncash deduction for depreciation . . . . . . . 10,000 Annual net cash inflow . . . . . . . . . . . . . . . . . . . . . . $30,000
When the annual net cash inflow is the same each year, this formula can be used to compute the payback period:
Payback period = Investment required Annual net cash inflow
Under these circumstances, machine A would probably be a better investment than machine B, even though machine B has a shorter payback period. Unfortunately, the payback method ignores all cash flows that occur after the payback period.
Is the process of allocating resources for major capital, or investment, expenditures.
Typical Capital Budgeting Decisions
Plant expansion
Equipment selection Equipment replacement
= $12,000 = 2.4 years $5,000
According to the payback calculations, York Company should purchase machine B because it has a shorter payback period than machine A
2. Preference decisions. Selecting from among several competing courses of action.
Typical Cash Outflows
Repairs and maintenance
Working capital
Initial investment
In addition, any depreciation deducted in arriving at the project’s net operating income must be added back to obtain the project’s expected annual net cash inflow. To illustrate, consider the following data:
Year . . . . . .
Stream 1. . . Stream 2. . .
0
1
ຫໍສະໝຸດ Baidu
2
3
4
5
6
7
8
$8,000 $2,000 $ 2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $8,000
$2,000
THE PAYBACK METHOD
Determine the payback period for an investment.
Example A
Required:
Which machine should be purchased according to the payback method? Machine A payback period = $15,000 = 3.0 years
$5,000
Machine B payback period
An Extended Example of Payback
The payback period is computed by dividing the investment in a project by the project’s annual net cash inflows.
If new equipment is replacing old equipment, then any salvage value to be received when disposing of the old equipment should be deducted from the cost of the new equipment, and only the incremental investment should be used in the payback computation.
Lease or buy
Cost reduction
Typical Capital Budgeting Decisions
Capital budgeting tends to fall into two broad categories.
1. Screening decisions. Does a proposed project meet some preset standard of acceptance?
York Company needs a New milling machine. The company is considering two machines: Machine A and Machine B. Machine A costs $15,000, has a useful life of ten years, and will reduce operating costs by $5,000 per year. Machine B costs only $12,000 will also reduce operating costs by $5,000 per year, but has a useful life of only five years.
Step 2: Compute the payback period. Using the annual net cash inflow from above, the payback period can be determined as follows: Cost of the new equipment . . . . . . . . . . . . . . $80,000 Less salvage value of old equipment . . . . . . 5,000 Investment required . . . . . . . . . . . . . . . . . . . . . $75,000 Payback period = = Investment required Annual net cash inflow $75,000 = 2.5 years $30,000
Therefore, projects that promise earlier returns are preferable to those that promise later returns.
• To illustrate, assume that for an investment of $8,000 you can purchase either of the two following streams of cash inflows:
Incremental operating costs
Typical Cash Inflows
Salvage value
Release of working capital Incremental revenues
Reduction of costs
Time Value of Money
A dollar today is worth more than a dollar a year from now.
The Payback Method
The payback period is the length of time that it takes for a project to recover its initial cost out of the cash receipts that it generates.
Example B:
Goodtime Fun Centers, Inc., operates amusement parks.
Some of the vending machines in one of its parks provide very little revenue, so the company is considering removing the machines and installing equipment to dispense soft ice cream. The equipment would cost $80,000 and have an eight-year useful life with no salvage value. Incremental annual revenues and costs associated with the sale of ice cream would be as follows:
CAPITAL BUDGETING DECISIONS
Group 8 Reporters: 1. Abigail Tamundong 2. Manolo S. Baccay, Jr. 3. Cyrene Cauilan 4. Marietoni Fernandez
CAPITAL BUDGETING
Evaluation of the Payback Method
To illustrate, refer back to Example A on the previous page. Machine B has a shorter payback period than machine A, but it has a useful life of only 5 years rather than 10 years for machine A. Machine B would have to be purchased twice—once immediately and then again after the fifth year—to provide the same service as just one machine A.